Strategies for differentiating between LIHTC and conventional apartments
"In most jurisdictions, the assessor's statutory responsibility is to value a property at its market value as of a particular date. Assessors often have difficulty incorporating the restrictions spelled out in a tax credit property's Land Use Restriction Agreement (LURA)..."
Owners of low-income housing tax credit (LIHTC) properties face an unending struggle to keep their property tax assessments at a reasonable level. The fight continues because local assessing authorities receive little guidance from state legislatures and courts on how to account for the unique characteristics of a LIHTC project. Thus, assessors derive a tax credit project's assessment from traditional methods of valuing conventional apartments. Unfortunately, this approach can lead to inflated assessments.
No uniform approach
There is often little consensus across state taxing jurisdictions regarding how to account for tax credits in the valuation equation. Some jurisdictions include the value of the LIHTC allocation as part of a property's net operating income under the contention that the tax credits enhance a project's value in a way that a prospective buyer would take into account when estimating the property's value. The resulting higher property taxes make low-income housing less economically feasible, which undermines the credit program's goal of encouraging the development of affordable housing.
Other jurisdictions exclude tax credits from a project's income, arguing that inclusion of the tax credits leads to excessive assessments. LIHTC property owners should educate themselves on how their local assessor accounts for tax credits in the valuation process. Only then can they begin a meaningful conversation about LIHTC valuations versus conventional complex assessments.
In most jurisdictions, the assessor's statutory responsibility is to value a property at its market value as of a particular date. Assessors often have difficulty incorporating the restrictions spelled out in a tax credit property's Land Use Restriction Agreement (LURA) into their valuation analysis, so they fall back on three classic approaches to value: cost, sales comparison, and income.
It often falls on the LIHTC property owner to show the assessor why tax credit properties defy conventional market value definitions and approaches to value. In that discussion with the assessor, the property owner should incorporate the following points:
Cost and sales-comparison approaches inapplicable
The cost and sales approaches to value are almost never reliable methodologies for tax credit projects, and owners should aggressively protest valuations derived from these approaches.
A cost-based assessment is rarely a reliable value indicator for any multifamily project, much less a tax credit property. And development costs for a LIHTC project usually exceed those of similarly sized conventional projects, given the additional amenities required under the LURA. In addition, a replacement or reproduction cost estimate excludes value associated with the future tax credits and ignores income lost due to restrictions in the LURA.
It is easy to apply the salescomparison approach to a conventional complex because these properties trade frequently in the open marketplace. Sales of LIHTC projects are rare, and the terms and conditions may render the sales data unreliable.
For example, a transfer may occur under a "right of first refusal," in which case the sale price is negotiated well before the transfer date and may not relate to current market value. If the transfer is under a "qualified offer," then the price is based on a statutory formula unrelated to market conditions.
The modified income approach for LIHTC properties
The income approach is the most reliable valuation methodology to derive a tax credit project's property tax assessment, but it requires some special treatment. Typically, assessors using this approach will apply market rents, expense ratios, and capitalization rates into a direct-income pro forma to value the real estate. Owners of tax credit properties should argue for a modified income approach to account for key differences between conventional and LIHTC apartment projects. Here are the major differences:
1. Rents. A tax credit property operates under limited income potential due to the restrictions associated with the LURA and LIHTC regulations. Specifically, rental rate restrictions cause rents per unit to be much lower for a LIHTC project than for conventional properties.
A market rent factor derived from rental data associated with conventional apartment projects will lead to an inflated indication of effective gross income for a LIHTC project and, ultimately, an excessive assessment. Tax credit owners should argue for the use of their actual restricted rent amounts in the income analysis to arrive at a realistic representation of the property's income potential.
2. Expenses. Tax credit properties require management expertise and administrative duties that run up operating costs above those of conventional projects. Tax credit properties also see higher turnover rates than conventional apartments, so make-ready costs are greater.
Finally, rental rates are limited but expenses are not, so the actual expense ratios for tax credit projects are often well above the ratios assessors are willing to use for conventional apartments. LIHTC owners should provide the assessor with a copy of the LURA and point out the requirements that cause expenses to exceed conventional levels.
3. Marketability and capitalization rate. In their income analyses, assessors rely on a capitalization rate, or a buyer's initial annual rate of return based on price and the property's net income.
Assessors typically derive capitalization rates from sales of conventional apartments sold under the willing buyer, willing seller concept associated with most market value definitions.
As previously discussed, tax credit properties rarely sell. If a LIHTC complex does sell, the LURA dictates who the property can be sold to. What's more, tax credits expire after 10 years, but the restrictions may last for another 20 years, and the property's restrictions survive a sale. A purchaser would, in effect, be buying only the restrictions without getting the benefit of the credits. These factors make for an extremely illiquid and unmarketable asset.
A tax credit owner should argue that the assessment take into account the subject property's illiquidity, and the most logical place to do that is in the capitalization rate. The capitalization rate for a tax credit property should be higher than the rates used for conventional projects.
Using these talking points will help LIHTC owners demonstrate to the assessor the differences between tax credit and conventional apartments, which will ultimately lead to reduced assessments and property taxes.